Inflation Excerpts

World prices of all basic foods - cereals, edible oils, meat - have skyrocketed in the last year, causing political tremors across developing countries. But they have not caused tremors in the US. Why not? Because most of the cost of a loaf of bread in the US is on account of processing, packaging, advertising and trade margins. So, a 100% rise in wheat price may translate into just a 2% rise for a loaf of bread.

These other components of a loaf's price may be amenable to monetary policy. So, in rich countries, most inflation may indeed be monetary. But even there, central banks recognize that food and fuel are less amenable to monetary manipulation than other items. So the European Central Bank, Bank of England and US Federal Reserve Board target not overall inflation but core inflation - that is, prices other than those of food and fuel. Monetary policy is even more helpless to combat inflation in poor countries, where food and fuel account for a big chunk of the consumer price index. If the RBI raises interest rates and cuts money supply, it will hit industrial production without reducing food prices.

That is why several poor countries have used not monetary policy but changes in import-export policy to curb food inflation. India is not alone in abolishing import taxes on imported food items and banning the export of food staples. China, Thailand, Indonesia, Vietnam, Egypt, Ethiopia, Kazakhstan and Cambodia have done likewise

Friedman was simply wrong in saying that inflation is always and everywhere a monetary phenomenon. It is not the case in poor countries where droughts or a sharp fall in global availability have suddenly caused inflation.

In India, the Raghuram Rajan Committee has just suggested that the Reserve Bank of India should cut down on its current multi-tasking, which covers exchange rates, growth and inflation, and focus principally on inflation control. But in Indian conditions, non-core inflation is often the dominant part of inflation, and in such cases monetary policy is a weak tool to curb prices. India is not Europe, and so the RBI should not try to behave like the European central bank.